As refinance volume begins to pick up again, there is renewed joy in the originations departments of many lenders.

However, this joy is matched by gloom in the servicing area. Servicing portfolios are generating results that just about cancel out new loan applications for many lenders.

Even as origination volume increases, many lenders are not seeing any increase in servicing portfolios, but must run as fast as they can just to stay in place.

Customer retention is a strategy to maintain and increase servicing portfolio size, and there are several tactics a lender can use to do this. A June 23 column in American Banker ("Ways to Cut Losses from a Refi Revival") listed several tactics for retaining customers.

There are compelling financial reasons for a mortgage lender to pursue retaining its own customers in a much more proactive fashion. The principal one is the cost of origination. While estimates of the unit cost to originate a loan vary, recent articles estimate $2,500 as a reasonable industry average.

While this cost covers many different aspects of the whole origination process, the major portion is attributable to attracting and selling the customer in the first place. For argument's sake, let us make a reasonable assumption that getting the customer in the door and taking the application account for 40% to 60% of the unit origination cost. Thus, this part of the origination process costs an average mortgage lender between $1,000 and $1,500.

For the purposes of revenue and profit generation, once a loan is on the books, it does not matter if the loan was a new application or a retained present customer. Thus, if a customer can be retained for less than $1,000, the lender has every financial incentive to pursue that retention, even at some investment cost. The lender can become much more proactive and spend more money - up to $1,000 - to retain customers than is commonly thought.

This is true because retention is a one-for-one equivalent of new origination in terms of both expanding servicing portfolio levels and building revenue.

Successful retention also can reduce the effective cost of building the servicing portfolio (a proxy for the unit cost of origination) by bringing in "new" loans for $1,000 or less, compared to the $1,000 to $1,500 that a new origination costs.

With the recent history of portfolio ARM lending, however, and with these readjusting ARM borrowers identified as prime candidates for refinancing status due to lower fixed rates, there is an even better way to cut costs of building the portfolio: modification. If you are a lender with a portfolio of loans on your own balance sheet, or if some of your investors permit, simply modify loans in your servicing portfolio instead of refinancing them.

The cost of modifications is truly minimal - no processing, underwriting, closing, or postclosing costs at all - and so an existing loan retained via modifications as part of a successful retention program can cost less than $1,000, compared to the full-blown origination cost of $2,500, and really bring down the average cost to build your servicing portfolio.

Throughout this article, I have used $1,000 as a cost for retaining customers, based on the floor unit cost for attracting and receiving applications from new borrowers. To the extent that a lender can retain customers for less than $1,000, the lender adds to the cost side.

But the main point of this article is that retention is something that lenders should pursue vigorously and regard retention expense as a cost- reducing investment to replace more expensive forms of origination in times of refinancing.

Mr. Neagle is a managing consultant for EDS Management Consulting Services, based in Rosemont, Ill.

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